Equity financing: 3 things to consider

Equity financing: 3 things to consider

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Published in : Business finance

Published on 28 March 2019

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Equity financing: 3 things to consider

Looking for financing to market a new product or acquire a competitor? If you’re hoping to avoid overleveraging your SME, equity financing could be a solution. Here’s what you need to know on the subject.

Equity financing enables companies to receive additional funds without accumulating more debt. But to obtain it, entrepreneurs need to surrender a percentage of the ownership of their business. “These shareholders will then have a right to a share of the profits earned by the company in the form of dividends,” explains Roland Léger, Associate Vice-President, Technological Innovations at Desjardins Capital.

If things don’t work out as planned, the company does not have to refund the investments and investors could lose their seed money. Before opting for this financing solution, entrepreneurs should consider all the angles.

1) Consider the burden of regulation

Financing by shareholder equity offers many advantages. However, it is tightly controlled by regulatory bodies. “Any financing of a private business in Quebec normally has to be backed by a prospectus in order to obtain the necessary approvals.”

However, you will be exempted from having to provide a prospectus if the issuing of shares is made exclusively by friends and family members. If the outside investors—angel investors or venture capital firms, for example—are brought in through issuing capital stock, they must hold the status of “qualified investor” if you hope to obtain regulatory approval.

These investors must have above-average revenues or hold significant assets. The specific requirements are listed in Regulation 45-106 on prospectus exemptions by the Autorité des marchés financiers (AMF). “This means you cannot issue equity interests without prior preparation and without conforming to current regulations,” Léger explains.

2) Offer capital stock to a partner you can trust

“Choose your investors wisely,” emphasizes Léger. “Financing will enable you to take care of your issue in the short term. But if problems multiply in the long term as a result of a dispute with an investor chosen too hastily, you could find yourself in dire straits.” Hence the importance of drawing up an agreement between shareholders in preparation for possible issues that may arise in the future.

Your partner’s involvement is not limited to their injection of capital into your business. At Desjardins Capital, entrepreneurs can rely on vast expertise, a well-established network of contacts and a lot of experience financing SMEs just like theirs. “The right partner can make all the difference between success and failure,” says Léger.

3) Negotiate skilfully by being informed

Once trustworthy partners have been identified, negotiations will revolve around many issues. “The value of the company, the capital outlay by the investor and the portion of the company expected in return are just a few points up for negotiation,” explains Léger. Plus there are several types of equity interests that can be used to clarify your financial arrangement. Common shares (either voting or simply participating shares) and preferred shares each have their own characteristics. Partners could also agree to special provisions attached to either type of share. “Everything is negotiable when it comes to this kind of transaction,” Léger states.

Finally, expect stiff competition for potential investors, who are usually highly sought-after. “The higher the amount you are looking for, the more you need to prepare. You should really do your homework,” concludes Léger.